Monday, April 9, 2012

The correction has begun

Stocks had a bad day following Friday's weaker than expected employment report.  The prevailing wisdom on the street is that this will be a buying opportunity as the rally should continue through the year.  I'm not so sure.

First of all, we have seasonal factors to contend with.  Stocks typically outperform from November through April and under perform from May through October.  This seasonality was especially pronounced in 2010 and 2011.

Secondly, events in Europe are heating up.  There's pressure on Spanish bonds which is problematic if it continues but the real concerns are political.  There are French and Greek elections in April.  It appears Hollande in France has the backing to defeat Sarkozy.  Being a Socialist this could create some tensions in the European Union and there will have to be an understanding with Merkel.  But Greece is an economic and financial basket case.  Capital has been fleeing the country for months and the situation is dire.  Various extreme political groups from rabid fascists to communists are gaining enough political traction to split the government to the point where there will be no political consensus and the new government is liable to backtrack on its commitments that were given to guarantee the last tranche of aid.  Greece will leave the Euro.  There's enough politically induced volatility between these three factors to provide quite a roller coaster market for our stock market.

Thirdly, commodities  are still manifesting the kind of price action which has concerned me since early February.  Which dovetails into my fourth point:

The market is spooked because the FED appears to be cutting off the spigot of easy money which has "floated all boats" since March 2009.  Recent comments out of the latest FED meeting minutes seem to indicate a "wait and see" as it appears our economy is gaining some measure of positive steam. 

With all that said, the Bulls still hold the high ground as seen on the two charts below:

(click on chart for larger image)

Here's a daily chart of the Dow Jones Industrial Average and I've highlighted the weak momentum readings with red arrows and dashed lines.  With today's 1% decline the Dow closed below its 50 day moving average which is not a good sign but a break below the green dashed line which goes back to March 2011 would be much more problematic and portend a much steeper decline.

And here's a weekly chart of the Russell 2000:


Here too I've highlighted resistance and support on the chart and I circled the price action for the past two weeks.  The bottom panel shows the relative under performance of the Russell to the S&P 500.  It must be remembered that the Russell which is a small cap index led the rally that commenced in late December.  However, with all these negatives, until the Russell penetrates the blue dashed line (775 level; it closed today at 803.46) all we can say is that stocks are experiencing a normal retrenchment in an ongoing bull market.

We'll see how it all plays out this week as first quarter earning season commences tomorrow.